If the spread continues, DB deficits could double to £900bn

The financial impact of coronavirus contributed to the rise of UK Defined Benefit (DB) pension scheme deficits by around £100bn in the last week of February, taking solvency deficits to around £500bn according to analysis from Hymans Robertson.

If coronavirus continues to spread, the leading pensions and financial services consultancy predicts that this could cause a supply side macroeconomic shock, which has the potential to double solvency deficits to £900bn. The related heightened market volatility in the wake of the coronavirus epidemic will also increase the degree of variability in funding positions.

Commenting on how the impact on the markets will affect pension schemes Calum Cooper, Partner at Hymans Robertson says:

“If efforts to contain the virus fail, companies may struggle to meet demand which could cause a ‘supply shock’ that will be felt in the global markets. If this was to happen the effects would be felt by pension schemes in the shape of a c.14% increase in liabilities and a drop-in solvency funding levels by c.16% of £400bn. This could be attributed to an expected sharp fall in shares, property and commodity prices and changing currency movements causing emerging market bond yields to rise and ‘safe haven’ currencies such as the USD, JPY and CHF to outperform. While the impact of this will not be felt evenly by every pension scheme it could become a very real challenge for a sizable minority.

“The virus could also lead to one-off shocks in longevity. Latest estimates* are that the overall mortality rate of those infected is around 2.3%. If similar mortality rates impacted the UK, and we assume that around 1/3 of the UK population get COVID-19, then would lead to an average 1% fall in liabilities in isolation. In addition, the impact on sponsor cashflows could significantly weaken the strength of sponsor covenants. All this at a time when the regulatory funding regime is on the cusp of getting a lot stricter.”

Commenting on how schemes can prepare, Calum, continues:

“The ongoing Coronavirus outbreak is a 'here and now' reminder of a disease which could become a pandemic. The ripple effect from this crisis will be felt across the world across a number of industries and pensions will not be immune from that.  The epidemic is already being compared to the Spanish influenza outbreak of 1918 which, alongside the tragic human consequences led to a c.5% contraction in global GDP. If today’s market was to contract in a similar way, it could lead to a $3.5trn persistent reduction in global equity market capitalisation. Roughly equal to a year of the UK’s entire economic output.

“A move of this size would likely mean that schemes will have to extend their time line for reaching their Long Term Objectives. Whether this is manageable depends on each sponsor’s covenant looking strong enough for long enough to support this, which may in these uncertain times be less likely. Schemes with low levels of hedging and a high allocation to high growth assets may find themselves in an even more challenging situation.

“Taking the time to understand the covenant implications should be the top priority for all DB schemes as this will influence any near-term strategic interventions. Ensuring that you could continue to pay pensions through a pandemic is crucial too. Equally important is ensuring your central strategy is thoroughly stress-tested and that contingency plans are in place, workable and understood by relevant stakeholders. By taking these strategic steps today, schemes could ensure they are in the best position possible to with stand any side-effects of Covid-19 and any other Pensions Pandemic.”

* Club Vita, Pandemic Panic article https://www.clubvita.co.uk/news-and-insights/pandemic-panic1